Euro Faces Energy Price and Political Risk Tests as Dollar Strength Bites
By Aboki Forex —
The euro is trading near its lowest levels of the year against the dollar, caught between a global energy shock and mounting political risk across Europe.
The currency has weakened this year, with a stronger dollar following a U.S. rate rise adding to the pressure. European gas prices have risen above their highest level since late 2022, and the premium investors demand to hold French 10-year government bonds over German debt has climbed above its recent range.
Political risk in Berlin and Paris
The euro's outlook has been complicated by political developments in Europe's two largest economies. German Chancellor is facing pressure following strong results for the far right in recent state elections. The developments could force his government to dilute its planned reform agenda.
In France, markets remain under pressure from concerns over the country ahead of its 2027 presidential election. A Rabobank senior currency strategist said the euro's outlook was concerning in that environment, adding that her forecast was under review.
Bond spread and options positioning
The premium investors demand to hold French 10-year government bonds over highly rated German debt has risen above its previous level. BofA FX strategists estimate that every additional point in the spread could be associated with approximately a move in the euro.
Options markets are also showing greater negative positioning toward the euro. Three-month euro risk reversals recorded their largest weekly decline since the beginning of the Iran war.
What is holding the euro up
Despite the pressure, there are factors supporting the single currency. Markets are pricing in at least further policy action, while recent economic data has shown greater resilience than expected.
High energy prices remain the biggest concern. The Iran conflict has disrupted liquefied natural gas shipments through a key route, pushing European gas prices above their highest level since late 2022 this month. Analysts said gas prices would need to fall for the euro to resume its previous advance, but they do not expect significant relief in the immediate future.
An RBC BlueBay Asset Management senior portfolio manager said commodity forecasters were generally expecting European gas prices to remain in a range. He added that if prices reached those levels, the euro could potentially fall toward a weaker level.
An ING currency strategist said a rise in oil prices toward a higher mark would increase pressure on the euro because such levels could heighten concerns about economic growth. He noted, however, that if central banks remain hawkish, the euro should not experience a sharp depreciation. A possible U.S. ban on diesel exports could add to pressure, although analysts said this was not their main scenario.